April 10, 2011

The Brain on Trading: Emotional Intelligence and the Trader’s

Posted By: Rande Howell

An Emotional Braking System Failure

“I left money on the table yesterday, and I’m not going to leave money on the table this time!” Harry silently declared, “I’ve missed out too many times – I’m going to ride this one and clean up.” Harry could feel the excitement pulsing in his veins – he could hardly contain himself. He pushed beyond his exit point, knowing that this one was going up. What a rush! Harry could feel the surge of energy. He almost became giddy as he saw the numbers climb even higher. That triggered even more excitement as he thought, “I’ve hooked a big one – I’ll show them who’s a trader!”

In the blink of an eye, without explanation, the trade went against him. Harry kept waiting for the downward spiral to right itself. It didn’t. Harry moved the stop because he knew in his gut that it would go back up again. It didn’t. Finally Harry pulled the trigger and accepted that he had another draw down on his trading account. He felt frustrated because, in his irrational exuberance (some would call it greed), and he let a perfectly good trade go bad. He had sabotaged himself yet again. Now Harry felt shame and wondered, “What made me think that I could trade for a living?”

You Trade Your Psychology

What happened to Harry? How did he get suckered into bad trading practices? From the sidelines, it is easy to say that Harry neglected to trade his plan. This assertion misses one big point about humans (and particularly the ones who trade) – emotions rule mind. Out of your emotional states comes the kind and quality of the thinking of which you are capable. In Harry’s case the state of mind that he needed to trade effectively was swept away by a fear of missing out. Once this fear triggered and accelerated, his thinking became clouded and his rational evaluation process was blown out of the water.

Like many traders, Harry did not have the skill sets to keep his emotions regulated as he entered the trade. Consequently, a guy who had diligently done his charting and was ready for the trading day got ambushed by unseen forces. His trading plan did not also include a psychological plan for managing emotions. This was a big mistake for Harry and for many traders. And until he learns how to make visible the unseen forces that hijacked his rational mind, his trading will suffer.

The problem is age old. Since the rise of Descartes’ rationalism, people (traders included) have attempted to separate body (emotions) and mind. Today, even Western medical science is concluding that this separation is impossible. The mind and the body (emotions) are woven together life a garment. They are inseparable. Maintaining awareness of your emotional nature as a trader is, in fact, the first step to developing a peak performance state of mind specifically for trading. Before this is explored, let’s take a look at what just happened to Harry.

The Anatomy of a State of Mind Hijacking

Harry experienced the trap of an undisciplined trader’s mind. As he moved into the trade, he was not attuned to what his hardwired and primitive emotional brain was biased to sense – nor how to manage the impulse. He did not notice the excitement of emotional arousal of the hunt that evolution had programmed into him. The thrill of the hunt (and its companion – the fear of missing out) was mobilizing Harry to pursue the prey before it could get away.

From a resting place where a calm, observant state of mind prevailed, Harry began to pursue the “hunt”, not noticing that his thinking was being compromised. (Remember, thinking is emotional state dependent.) The arousal of conquest or greed came to dominate his mind. He could no longer think rationally. Then he pursued his “prey”, consumed by the passion of taking no prisoners.

In this emotional stupor, Harry overtraded and lost. This trait of Harry’s (a single minded pursuit of winning big and being the best) had served Harry well in many areas of his life. It had helped him achieve many goals in his life, particularly in his career before trading. What he was beginning to recognize was that it did not serve him well as a trader though. What is different about trading?

Peak Performance and States of Arousal

In this discussion we are focusing on the component of an emotion called arousal. Arousal is preparation for action that happens in your body as an emotion prepares us for action. Powerful levels of adrenaline and cortisol are pumped into Harry’s body as he becomes excited by the trade. That excitement, as the arousal increases, becomes fixated on the object of pursuit – bringing down the home run trade.

This is called a high arousal and is a great component to some peak performance states of mind – particularly ones that more physical exertion and less cognitive functioning. Foot ball would be a good example of where peak performance demands high levels of arousal and reliance on instinct that has been trained into the athlete.

A peak performance trading state of mind requires low arousal. Impartiality, discernment, dispassion, and calm states of mind are the emotional components sought after for trading success. This is because cognitive functioning is what is necessary for trading peak performance, rather than physical exertion. The moment that high arousal states become apparent in trading, the trading has lost his capacity to take a step back emotionally and think impartially. You can be passionate about trading, but you cannot be passionate while trading.

Managing Arousal

Until a trader learns how to manage their emotional arousal levels, trying to use the mind to manage emotions often creates more (not less) stress and fixation. As an example imagine a chocoholic attempting to talk themselves out of wanting the warm fudge just coming out of the aromatic oven. The more you try to talk yourself out of the fixation, the more you want the chocolate. The arousal has already kicked started the desire to acquire.

Fortunately our breathing is both automatic and volitional – this is key to emotional regulation. If let on automatic, your breathing style will accelerate the arousal of an emotion as it triggers. In Harry’s case, his fear of missing out lead to the arousal of pursuit based on greed. He both held his breath and he then would breathe rapidly and shallowly. This excited breathing style accelerated his heart to beat faster adding to the excitement. The emotion greed and its motivation to grab all the profit he could, then took over Harry’s capacity to think impartially. And out of this emotional state, his thinking became compromised which lead to his over trading. It did not have to be this way.

Breathing is both automatic and volitional. With training, Harry has learned how to stay in a calm, impartial state of mind, in part, by managing the kind of breathing he does throughout a trading day. Once he understood that peak performance trading requires low arousal state of mind, he began using diaphragmatic breathing to manage his emotions while trading. He has much better control of his overtrading. He does not wait to feel arousal kick in. Instead, Harry using diaphragmatic breathing to help kept his emotions in check.

The moment he senses the triggering of arousal, he volitionally uses his breathing to cut off the gasoline supply to the fire of the aroused emotion. Rather than fear of missing out, greed, or a desire to pursue hijacking his mental faculties, he now is consciously able to calm the excitatory process of the emotional brain. Having learned how to manage the levels of adrenaline and cortisol in his body by managing breathing style, he is much less reactive in the management of his trading days. Harry now maintains a calm, impartial, and disciplined state of mind from which to trade.

In the process, Harry has learned how to change himself. His focus is on developing the skills and tools that allow him to trade at peak performance levels. And to let go of habitual historical practices that hinder his progress. His first step was becoming aware of the power that breathing has over emotional nature to influence states of mind.

Taking Back Your Edge From the Jaws of Fear: What You Need to Know About Emotions and Trading

By: Rande Howell

In the course of their evolution, every trader (if they are honest with themselves) has experienced disabling fear. How it happened – and why it continues to happen – often remain a mystery to the trader. Before the trader knows it, all reason has been hijacked and fear takes its toll on the trader’s state of mind, his capacity to trade effectively, and finally his trading account.

To the trader, it often appears that the fear came out of nowhere. Otherwise the trader’s problem with fear (or its cousin, greed) would be easily resolved. If not addressed, the fear stays in place and constricts the trader’s capacity to trade effectively. However there is an emotional process involved (common to all emotional states) that, with training, could have been successfully interrupted. Unfortunately, the trader is not aware of this process of emotional hijacking. The emotion has already seized him and he finds himself in hesitation, distraction, revenge trading, or impulsivity. And he begins to doubt that he is cut out for trading.

The good news is that there is a defined process to an emotional hijacking. Any emotional process has a signature that is associated with it. There would have been tell tale signs of the emotional hijacking, and a way to disrupt it, if the trader had known what to look for and had developed the awareness to be mindful of how fear triggers, accelerates, and overwhelms the calm disciplined mind required to trade effectively. You cannot get rid of emotions, but you can be trained to better understand them and manage them. It is out of this training that effective trading springs.

Case Example:

Jim has been trading for seven years. He has learned his methodology and was trading well until about two years ago. Since then his trading has been problematic. Fear began to surge as he traded and he found himself hesitating while evaluating set ups until emotional pressure built up. He would then jump into a trade impulsively. This flip-flop behavior continued until Jim decided to move back to paper trading – so he could refocus his trading and get his edge back. Of course, in paper trading, risk is removed from the equation of his edge.

Jim explains, “The challenge is that I haven’t been able to simulate the same emotional feelings when paper trading as when I’m trading live. I can’t seem to build up the fear I experience when live trading. But, you know, something weird happened when I recently went to a casino with my wife. I sat down at a slot machine next to her and slipped in $20. I thought I was just entertaining myself since I don’t gamble. After a couple of minutes of playing the machine I could feel the exact same feelings I get when I’m evaluating set ups. My heart rate started to increase, my palms started to sweat and I could actually feel small beads of sweat slowly dripping down from my armpits! There I was, triggered back to my trading room looking at set ups and trying to pull the trigger. I was frozen. This is the exact same emotional feelings I’ve been plagued by in my trading the past few months.

When I first started trading (7 years ago) I was never like this. Then about 2 years ago I lost a chunk of my capital and was basically wiped out until I was able to build my trading account up again. And I’ve had a couple of much smaller losses in the last 6 months also. I started going down hill after that. Now I doubt myself. I don’t understand why I can’t get my trading edge back. I see a connection between the experience I had at the slot machine and what’s happening in my trading – but I don’t understand it.

Threat, Brain, and Mind Meet in the Trading Room

Jim has just experienced a conditioned response that has generalized from one domain of experience to a broader context. He had been trading successfully for a number of years until he experienced a sudden loss of significant capital while trading two years ago. It is this sudden loss and the pain in the memory of that loss that Jim’s brain is programmed to avoid. To the survival brain, this sudden loss of capital represented a threat to the existence of the trader. And the brain’s mandate is to build a pattern of avoidance to the pain that became associated with this loss of capital. This part of the trader’s brain does not discern between loss of life and loss of capital. To it, any and all emotional painful losses constitute a threat to life.

Then the brain develops a fear response to the actual threat – the significant loss of capital – as a way to avoid loss in the future. This is the basis of traumatic memory and adaptation as part of a conditioned response. At this point the problem is as much a biological problem as it is a psychological problem. And they have to be handled together. It is the same process that a child experiences when he learns to never touch a hot stove top again… after traumatic pain. And for Jim the sudden loss of significant capital was traumatic to him. Imagine him having to tell his wife about the loss and the negative impact on his ability to survive in the world of no money. This is the set up for an automatic, reactive stress response.

The brain then builds an avoidant neural pattern as a solution to this problem. It becomes embedded in the pattern making and pattern recognition machinery of the brain. This is the conditioned response and pattern recognition that the brain orchestrates. And Jim does not help his cause. After the traumatic loss of capital and its fear response, Jim attempts to ignore his fear based on emotional pain and to push through the deeply embedded fear response to threat by sheer brut force – not a good idea. This only exaggerates the strength of the embedded pattern. As he keeps exposing himself to perceived threat, the survival brain generalizes the fear response from the specific environment where the pain actually occurred to any stimuli that risked capital. This is how he triggered to the fear response in the casino while risking only $20. In his mindlessness, he saw this as a form of entertainment. That is not how his survival brain was conditioned to react when risking capital and incurring emotional pain.

Significant pain has been hardwired to be associated with risk now – and will hijack state of mind if not disrupted. Not knowing how else to deal with it because he does not understand how the emotional brain and the psychological mind are intertwined, the triggering to fear becomes so great that Jim has to retreat back to paper trading in an attempt to “refocus” his mind. Unfortunately the brain was never designed to distinguish between biological fear and management of uncertainty. And Jim, like many traders, is clueless about how to deal with it. Until Jim incurred a traumatic capital loss, he never activated the level of primal fear that overwhelms the rational mind. But much like a person develops an irrational fear of all dogs after being bitten by one dangerous dog, now Jim’s mind has developed a self limiting fear of loss that taints the edge he used to have in trading. This is where neural-circuitry meets mind.

Calming the Raging Sea of Emotion

Before he gets to change his newly minted fear of loss which now corrupts the trading edge he used to have, Jim is going to have to learn to manage the arousal of the emotion of fear and its avoidance response to threat. Fortunately he has a clue as to how to do this.

In the casino he actually becomes witness to the arousal of his fear. This is a part of the emotion of fear that you can be trained to disrupt as part of emotional regulation. The arousal occurs before the emotion of fear takes over the mind of the trader. Here is Jim’s description of the arousal of the emotion of fear: “After a couple of minutes of playing the machine I could feel the exact same feelings I get when I evaluate set ups. My heart rate started to increase, my palms started to sweat and I could actually feel small beads of sweat slowly dripping down from my armpits!”

What he does not mention is that his breathing becomes shallow and rapid. The breathing actually started before the rest of the fear’s arousal. This is important because breathing can be used to regulate the arousal of an emotion – not control it, but manage it from overwhelming the trader’s mind. This is because breathing is the tool that can cool the body’s excitatory escalation of the fear reaction to perceived threat. Remember that his large capital loss got associated with loss of life in his primitive emotional brain. Because fear will have a breathing signature that is part of the emotion, breathing can also be used to manage and disrupt the power of the fear response.

By developing bellows breathing as part of managing his fear, Jim is able to calm his fear down. It is still there, but it is now workable and a very different mindset is now possible for him. It is through the calming affect of breathing and relaxation that Jim begins to work with this traumatically constructed self limiting belief embedded into his fear of loss. Now he can do the emotional labor required to deconstruct self limiting beliefs that have gripped his trading in the last 2 years and reclaim his belief in his trading edge. Emotional regulation is not the Holy Grail that changes self limiting patterns and beliefs. What breath training will do give you a tool that allows you to calm the fury of an emotional hijacking down so that you can begin to develop the psychology of peak performance. Before fear is tamed and re-understood, it will block your potential as a trader.

The Take Away

The purpose of this article is to show you how fear creates predictable patterns that govern a trader’s emotional nature (and hence his performances). And by understanding it, the trader learns how to manage the fear response. He now has begun to develop valuable tools and skills to change his relationship to fear and uncertainty. Learning this is an important step toward mastering your emotions and the inner game of trading. You have to equip yourself to build a peak performance state of mind. The first step in this process is emotional state management. Only then do get access to the mind. And it is in the mind that your self limiting beliefs and patterns dwell. This is also where many traders fail because they do not have the tool and skills to work with their emotional storms and hijackings. Effective trading is the pay off. Developing the skills and tools is the emotional labor you will need to invest in to achieve this aim.